Coke Is It

by Tom Gardner

Alexandria, VA (July 31, 1998) -- The Cash-King Portfolio took it on the chin today, just as the broader-market indices did. Everywhere you looked, stocks were falling three and four dollars. Over in the Fool Portfolio, it was Amazon down $3, Lucent down $3, and Starbucks down $5 1/2. In CK, it was Microsoft down $3 1/2, Intel down $3 1/4, American Express down $3 1/2, and Pfizer down $2.

On days like these -- which could turn into months like these -- I'm in the habit of returning to the financial standing of the Old Faithfuls. Our Coca-Cola shares fell $2 1/4, and there are certainly pundits out there who feel strongly that the end to Big Red's unbelievable run is long overdue. They ask how this business can trade at a price-to-earnings ratio of 52. Their instinct is to believe that only the most amateur individual investor would buy this stock at $80. They believe the end is nigh.

To give them their due, Coca-Cola shares could fall 30% in a bear-market thumping. To which your Cash-King managers will kick out a two-syllable party refrain, "Whoop-tee." Why? Because we feel very strongly that the ten-year picture for this business, given its powerful market position and sterling financials, points to a rewarding ten-year performance for the stock in the decade ahead.

Yes, it is on days like these, when our portfolio got squinched like a bluebottle fly, that I return to one of the greatest businesses of the 20th century, of any century. It is, after all, businesses and products and people that we're investing in here, not squiggle marks on a graph, greek alpha numerics, or numbers flashing on a screen. We'll let others play Keno in our public markets.

Let's take a look at Coca-Cola's numbers relative to six of the Cash-King criteria -- to refreshingly wash down this poor market day:

1. Repeat-Purchase Business

Yes, Coca-Cola benefits from repeated purchasing by people across the world, by the hour. Here in the U.S., the average person drinks more than one eight-ounce serving of a Coca-Cola product each day. Every single day of the year, our more than 270 million Americans go in for one Coke product. The world's other 6 billion inhabitants are moving toward that consumption rate as well. By doing so, earthlings (I was dying to use that word at some point) are becoming more familiar with the brand every day.

And with every passing hour, Big Red locks down ever more tightly the future demand for its products. Wall Street, in its feverish search for next week's big winner, badly under rates the long-term value of repeatedly-purchased convenience products. Like Coke.

2. Strong Historical Performance

The stock has compounded 16.7% annual growth during its eight decades in the public markets. To restate from The Motley Fool Investment Workbook, a $4,000 investment in Coca-Cola stock in 1919 is now worth more than $650 million after taxes. Lest you believe the company saw all its growth in the early days, Coca-Cola's stock has actually been growing faster than ever. Over the past ten years, it has appreciated 20x in value, or 35% per year. And had your purchased Coke on the worst possible day in the last quarter century, before KO began its 65% decline, and held on tight until today, you'd still have squashed the market's average performance under toe -- like a bruised grape.

3. Gross Margins Above 50%

The manufacturing costs of Coca-Cola's business are low, and lowering. Today, Coca-Cola's gross profit margins (gross profit divided by sales) are 70.4%. This is extremely important to your average Cash-King investor. It means that after subtracting out the manufacturing costs of mixing its syrups and concentrates, Coke has 70 cents per dollar of sales left over to invest in its business. With $4.5 billion in sales last quarter, that left over $3.1 billion to direct elsewhere -- like right into shareholders' pockets.

4. Net Margins Above 7%

Coca-Cola pours enormous investments into promoting its products across the globe, but because they're in a repeat-purchase business, the net cost of advertising can actually be reduced over time. When you walk into a restaurant and instinctively say, "A glass of ice water and a Coke, please," you illustrate how strong Big Red's position is in the marketplace. The reduction of the net cost of advertising helps Coca-Cola maintain net profit margins well above 7%.

In fact, Coke posted 19.2% after-tax margins last quarter.

5. Plenty of Cash

In the Cash-King Portfolio, we look for companies maintaining cash levels equal to or greater than 1.5x long-term debt. At various stages in a company's history, it may make acquisitions with borrowed money that throws this ratio out of whack. But in general, we like to find companies that have 1.5x more cash in the bank than borrowed money. That means they could pay down that debt, if they chose to (if the interest rates weren't so attractive).

In Coke's case, yep, they nail that easily. The company has $689 million in long-term debt and $2 billion in cash & marketable securities. That works out to 2.9x more cash than debt.

6. A Flow Ratio Below 1.25

In yesterday's column, I worked through the Foolish Flow Ratio, a calculation that we think is extremely important for Cash-King investors to master. Here's the equation again:

      current assets - cash & equivalents 
                 current liabilities 
 So here's Coke's Flowie: 
 Step 1. 
          $6.136 billion - $2.005 billion 
                   $7.500 billion 
 Step 2. 
                   $4.131 billion 
                   $7.500 billion 
 Step 3. 
             Coke's Flowie = 0.55 
There are very few companies in the world that have a Flow Ratio as low as that of Coca-Cola. Microsoft has the greatest Foolish Flow I've ever come across, at 0.29. And Microsoft's Flow has fallen from 0.39 last year down to that world-beating 0.29. Amazing. For this reason, as we've written in The Fool investment books, there are no two better companies on the planet than Coca-Cola and Microsoft.

I hope all CK investors understand that there really are no two better companies to learn from than Coke and Microsoft. No two companies better display financial might coupled with brand power than they. I've noted all these academics who claim that Mr. Softy and Big Red are ridiculously overpriced. You see, they've made one critical error in their analysis. They have focused on stock price and valuation before understanding how a financial system is modeled and built for years and decades to come. They've played Keno, rather than playing for keeps.

With that in our minds, on a down market day, I can think of no better way to close out the week than by reading through a wonderful and telling Fribble submitted to The Motley Fool by MFGreyhound on the Web. A gem: Opening the Window.

Have a great weekend.

Tom Gardner, Fool

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Today's Features -- It's what's going on at the Fool today.

07/31/98 Close

Stock  Change    Bid 
 AXP   -3 1/2   110.38 
 CHV   -2 5/8   82.63 
 CSCO  -2 11/16 95.75 
 KO    -2 1/4   80.50 
 GPS   -  7/8   59.63 
 EK    -1 5/8   83.88 
 XON   -1 13/16 70.25 
 GM    -  13/16 72.38 
 INTC  -3 5/16  84.38 
 MSFT  -3 7/16  109.94 
 PFE   -2 3/16  109.81 
 TROW  -1 1/16  35.50 
                  Day   Month    Year  History 
         C-K      -2.54%   1.34%  15.57%  15.57% 
         S&P:     -1.95%  -1.16%  11.92%  11.92% 
         NASDAQ:  -2.46%  -1.18%  13.28%  13.28% 
 Cash-King Stocks 
     Rec'd    #  Security     In At       Now    Change 
     2/3/98   24 Microsoft     78.27    109.94    40.46% 
     2/3/98   22 Pfizer        82.30    109.81    33.43% 
     5/1/98   37 Gap Inc.      51.09     59.63    16.71% 
    2/27/98   27 Coca-Cola     69.11     80.50    16.49% 
    6/23/98   23 Cisco Syst    86.35     95.75    10.89% 
    5/26/98   18 American E   104.07    110.38     6.06% 
     2/6/98   56 T. Rowe Pr    33.67     35.50     5.43% 
    2/13/98   22 Intel         84.67     84.38    -0.35% 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko    63.15     83.88    32.82% 
    3/12/98   20 Exxon         64.34     70.25     9.19% 
    3/12/98   17 General Mo    72.41     72.38    -0.04% 
    3/12/98   15 Chevron       83.34     82.63    -0.86% 
 Cash-King Stocks 
     Rec'd    #  Security     In At     Value    Change 
     2/3/98   24 Microsoft   1878.45   2638.50   $760.05 
     2/3/98   22 Pfizer      1810.58   2415.88   $605.30 
     5/1/98   37 Gap Inc.    1890.33   2206.13   $315.80 
    2/27/98   27 Coca-Cola   1865.89   2173.50   $307.61 
    6/23/98   23 Cisco Syst  1985.95   2202.25   $216.30 
    5/26/98   18 American E  1873.20   1986.75   $113.55 
     2/6/98   56 T. Rowe Pr  1885.70   1988.00   $102.30 
    2/13/98   22 Intel       1862.83   1856.25    -$6.58 
 Foolish Four Stocks 
     Rec'd    #  Security     In At     Value    Change 
    3/12/98   20 Eastman Ko  1262.95   1677.50   $414.55 
    3/12/98   20 Exxon       1286.70   1405.00   $118.30 
    3/12/98   17 General Mo  1230.89   1230.38    -$0.52 
    3/12/98   15 Chevron     1250.14   1239.38   -$10.77 
                               CASH     $94.76 
                              TOTAL  $23114.26 
 *The year for the S&P and Nasdaq will be as of 02/03/98